It is well known that if buyers or sellers want to trade a large quantity of stock that is disproportional to the stock's average trading volume, the buyers or sellers will pay a premium to the market price of the stock in order to execute the trade. This premium is exacerbated by current methods used to trade large orders of stock.
Currently there are many market participants, such as broker/dealers, specialists and hedge funds, who use quantitative analysis to value securities; they constantly scan the market for trading opportunities. In some respects, these types of traders are the wholesalers of the stock market. For example, where a mutual fund may feel they must dump a security after a bad earnings report, a broker/dealer, specialist or hedge fund may use a historical trading model to show an opportunity in acquiring the same security, thus providing liquidity to the market place and receiving a discount on the price of the security. Alternatively, a mutual fund may feel they must acquire a security after a good earnings report, thus pushing the security price up and providing a shorting opportunity for a broker/dealer, specialist or hedge fund. These current methods to receive a discount on the purchasing of securities and the shorting of inflated priced securities are inefficient because of the inherent risks involved with trading against short-term momentum of the securities.
With a large market order, for example, the broker/dealer or specialist and not the trader determines the price of execution. In some cases the broker/dealer or specialist has its own interest in the trade, but in most cases the automated systems that the broker/dealer or specialist uses to match buyers and sellers are simply inefficient and result in poor executions, leading to higher costs to traders.
Large limit orders posted on the NYSE (New York Stock Exchange), for example, attract traders who want to execute smaller orders with slightly improved prices in front of the larger order. The trader of the smaller order uses the larger order to provide a hedge or a barrier to protect the smaller order. The larger order gets hurt because the shares that should go to fill the larger order get rerouted to fill the smaller order. This increases the costs for traders who trade large orders.
Additionally, when traders place limit orders to buy they put themselves at risk for the possibility of a negative market moving event. If a negative market moving event occurs and the market falls sharply, many of the buy limit orders will be executed. If the buyers had information of such an event beforehand, they would have canceled their orders. By not having outstanding buy limit orders canceled and repriced to reflect the negative market moving event, the execution of these orders results in securities being purchased at inflated prices and, thus, trading losses.
Institutional investors invest large amounts of money in securities. They make their money charging fees on the amounts of money they manage, and they usually trade in large quantities of securities. Institutional investors can either buy securities in the open market or they can negotiate though intermediaries. When institutional investors buy large quantities of securities in the open market, they end up paying a premium above the current market value of the securities because they upset the market price in those securities. This is due to an increase in their acquisition costs because large quantities of securities usually cannot be bought in the open market with a single order, but rather with several manageable smaller orders resulting in multiple commissions and slippage (moving prices higher while attempting to acquire securities). When institutional investors use intermediaries, they are limited to a small pool of other institutional investors that use the same intermediary. So even if they are able to negotiate a trade using an intermediary, the price may not be to the advantage of the institutional investor. They also run the risk of letting the word out on the street that a large buyer is seeking to trade a particular security; this information leak can increase the acquisition costs for institutional investors.
Accordingly, there is a need in the art for a system and method that allows traders to reduce the risks of purchasing securities at discounted prices and reduce the risks of selling short securities at inflated prices, as well as a need to reduce the negative price impact currently associated with the trading of large orders, as well as a need to reduce trading losses due to market moving events.